FDIC backs ban on banks trading for own profit

WASHINGTON — Banks would be barred from trading for their own profit instead of their clients under a rule federal regulators proposed today.

The Federal Deposit Insurance Corp. backed the draft rule on a 3-0 vote. The ban on so-called proprietary trading was required under the financial overhaul law.

For years, banks had bet on risky investments with their own money. But when those bets go bad and banks fail, taxpayers could be forced to bail them out. That’s what happened during the 2008 financial crisis.

The Federal Reserve has also approved the draft of the Volcker Rule, named after former Fed Chairman Paul Volcker.

The Securities and Exchange Commission and a Treasury Department agency must still vote on it, and then the public has until January 13 to comment. The rule is expected to take effect next year after a final vote by all four regulators.

A ban on proprietary trading could help President Barack Obama in next year’s election by showing he has adopted tough rules to rein in risky trading on Wall Street. It might also lead some of the protesters on Wall Street to rally to his campaign.

The Volcker Rule was a key part of the financial overhaul law intended to blunt criticism that Obama was too lenient on the banks. He continued the bank bailouts that had begun under President George W. Bush.

Congress and Obama had high hopes for the rule. But they left most of the details for regulators to sort out. It’s unclear how strictly the ban will be enforced.

Many contend that the rule’s effect on risk-taking will be limited. Banks have a history of working around rules and exploiting loopholes. In this case, banks can make most trades simply by arguing that the trade offsets another risk that the bank bet on.

The rule was proposed by the Fed. Some critics argue the Fed often capitulates when bankers complain that regulations make it harder for them to do business.

Wall Street banks say the ban on proprietary trading could prevent them from buying and selling investments that their customers might want. It would also put U.S. financial firms at a competitive disadvantage to those in other countries.

At the same time, several big U.S. banks have already shut down their proprietary trading operations in response to the financial overhaul. Critics say they have merely spread those traders across other desks without ending their risky practices.

The rule also would limit banks’ investments in hedge funds and private equity funds, which are lightly regulated investment pools. Banks wouldn’t be allowed to own more than 3 percent of such a fund. In addition, a bank’s investments in such a fund couldn’t exceed 3 percent of its capital.

Before Congress passed the financial regulatory overhaul, banks had no limit on how much of those funds they could own. Still, typically on Wall Street, such investments already fall below the 3 percent threshold.

Banks could still put their clients’ money into those funds. They will still be able to manage such funds, and collect fees and a percentage of trading profits.